Excelsior Capital (ASX:ECL) has had a great run on the share market with its stock up by a significant 32% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Excelsior Capital's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Excelsior Capital is:
7.4% = AU$3.6m ÷ AU$49m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.07 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Excelsior Capital's Earnings Growth And 7.4% ROE
On the face of it, Excelsior Capital's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.7%, so we won't completely dismiss the company. Having said that, Excelsior Capital's net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.
We then compared Excelsior Capital's net income growth with the industry and found that the average industry growth rate was 12% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Excelsior Capital fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Excelsior Capital Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 44% (or a retention ratio of 56%), Excelsior Capital hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, Excelsior Capital has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Overall, we have mixed feelings about Excelsior Capital. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Excelsior Capital's past profit growth, check out this visualization of past earnings, revenue and cash flows.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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